US broad money growth has normalised even as the numbers remain inflated by the tail end of the Fed’s QE programme.

The broad money measure calculated here – “M2+”, which adds large time deposits at commercial banks and money fund balances to the official M2 measure – rose at an annualised rate of 5.4% in the three months to February, only slightly higher than a 4.5% average over 2015-19, when the Fed’s core inflation measure was mostly below the 2% target.

Chart 1

The Fed’s securities holdings rose by the equivalent of 3.8 pp of M2+ expressed at an annualised rate in the three months to February.

Current Fed signals suggest a mid-year start to QT. Broad money momentum could fall to a weak level in H2 unless bank lending grows strongly.

Commercial bank loan expansion was rapid in late 2021, partly reflecting high stockbuilding, but cooled in January / February, while demand for home loans could plunge in response to the recent surge in mortgage rates.

The monetary slowdown, as usual, will feed through to inflation with a “long and variable” lag but a reasonable expectation – assuming that current (or lower) growth is sustained – is that core price momentum would return to target during H2 2023.

The slowdown supports the message from the Wu-Xia shadow fed funds rate that there has already been a significant effective policy tightening via the withdrawal of “unconventional” support measures (QE, forward guidance, etc). The shadow rate uses information from the term structure of interest rates to quantify the impact of such measures when the policy rate is at the lower bound. The suggestion is that last week’s quarter-point hike was the ninth not first such move in the Fed’s tightening sequence – chart 2. (This casts doubt on market prognoses based on examining behaviour after previous first Fed hikes.)

Chart 2

The current conjuncture has some similarity to early 2016. The shadow rate had risen significantly during 2015 as the Fed wound down QE before its first hike in December. Subsequent US / global economic weakness caused policy-makers to defer the next hike for 12 months (i.e. until December 2016).

There are two key differences. The obvious one is inflation – core was below target during 2015-16, giving the Fed scope to execute a “dovish pivot” as economic news and markets weakened. In addition, the global stockbuilding cycle was nearing a low when the Fed hiked in December 2015. The current assessment here is that it is beginning a downswing, with a trough unlikely to be reached until 2023. Central banks lag the cycle and typically remain hawkish until well into the downswing (thereby magnifying the cycle).

Both considerations suggest a more sustained Fed tightening campaign – albeit increasingly questionable from a “monetarist” perspective – with a correspondingly much higher risk of a recessionary outcome than in 2016.